This is a crucial idea for productivity and efficiency, especially when you consider all the different ways you can use in your life.
Economic theory uses the term "opportunity cost" to refer to the cost calculated based on opportunity value, meaning what you might lose by choosing to do one thing over another. This is a crucial idea for productivity and efficiency, especially when you consider all the different ways you can use in your life.
Economy
Let's take another look at that definition “the cost calculated based on opportunity value.” Basically, this means that if you have two options, A and B, the opportunity cost of choosing A is the value you would gain from not choosing B. Here's a very clear, real-world example: A businessman who has a busy Friday night swaps out 6 hours of partying with friends for 6 hours of work in the office.
By definition, opportunity cost is the value gained from the activities he missed. This value can be measured in units of happiness or enjoyment. However, the situation is more complicated than that. You can also take into account the value gained from those 6 hours of work and the potential financial loss from going out to dinner or ordering more drinks.
Taking these things into consideration, we need to look at opportunity cost through practice, rather than just theory.
Real world
When it comes to applying the concept of opportunity cost in the real world, we can't use possible subjective measures like "happiness units." We can only objectively define time and money.
1. Money
Let's start with the easy one: money.
Money is obviously the simplest step because most things have a monetary value. Since money is a renewable resource, your alternatives are limitless. For example, if you decide not to purchase item A this week, you can wait and do so with your paycheck the next week.
The best way to calculate the opportunity cost of money is by tracking your income and expenses and calculating your real hourly wage "credit: your money or your life."
You can either use a pen and paper or any smartphone app for tracking your budget, like "iXpenseIt," "Money," or "MoneyWell." At the end of each month, calculate your expenses and income and see what they are.
Write down your annual income and then calculate how much time you spend working and engaging in work-related activities to determine your real hourly wage. You must first subtract any costs associated with your job from your income or salary, such as uniform, clothing, or travel costs. Travel time, overtime, and other work-related activities that take place outside of regular business hours should also be included.
Here comes the interesting part. Find out how many business hours it took you to purchase each expense item. To do this, divide the item value by the real hourly wage.
For example, suppose that your real hourly wage is $12 and you spend $60 on drinks with your coworkers every Friday. Thus, those drinks cost 5 hours of work.
So, you should ask yourself if 2 hours of fun with friends at a coffee shop on a friday night equals 5 hours of work, then what is the opportunity cost of those 5 hours? In terms of money and other value, $60 could be equal to 2-3 days of eating out, a year's subscription to a magazine you love, or 5 extra hours with your family.
This is what we mean by opportunity cost, as it is not always clear what we are giving up exactly when we make purchase decisions.
2. Time
Unlike money, time is not something you can get back. Once the time has passed, it is gone forever. You should also consider that there are certain things that you can only do at a specific time, and you will never have the chance to pursue that opportunity again. You must pay attention to these things because if you miss them, they won't be available to you again.
For example:
- Offers and job opportunities limited to a certain time.
- Seeing someone you're attracted to walk past you on the sidewalk, and thinking about going and greeting them.
- Exercises.
- Whether or not to stay in an abusive relationship.
In addition to these opportunities that disappear forever, you can also put a monetary value for time to calculate opportunity cost. By taking your real hourly wage, you can decide whether an hour of watching TV is worth $12, or whether a T-shirt that costs $60 equals watching TV for 5 hours.
3. Health
Your physical health is also something you can think of using opportunity cost. A hearty meal of burger, fries, and soda might seem like the right thing to eat at the moment, but consider the later cost, which is spending more time in the gym, lower energy later when the high sugar level crashes, and fewer meals in the future due to reduced shelf life.
Therefore, physical exercise is one of the best ways to spend your time. It's not something you can do later, and it definitely outweighs the opportunity cost of other alternative activities. Exercising properly will make you live longer, work more productively, enjoy life more, and provide you with all kinds of social benefits.
4. Focus and Motivation
Focus and motivation are renewable resources that are depleted through work and other activities, as they are "spendable" things and you can use them to calculate opportunity cost as well.
For example, after 40 hours of intense focus on a project, it is likely that 2-3 days off are needed to regain energy. Furthermore, 40 hours of focus can be used for other things, such as assisting your children with their homework, working on personal projects around the house, preparing for the GMAT, etc.
Think about the value that's missing in all these other activities before you adopt the - unfortunately common - principle that you have to work all the time.
You can renew focus and motivation by taking time off from work and changing your lifestyle.
Downtime includes things like entertainment (watching TV, video games, going outside,) social time with people you enjoy their company, vacations, and breaks. Lifestyle is primarily about physical health and energy levels.
Simple examples
To illustrate how all of this fits into your daily life, let's discuss some common opportunity cost trade-off examples.
1. Project selection: What profession "industry" should I enter?
Practicing a profession is the quickest way to get a stable income. Entrepreneurship might pay off over time, but the entrepreneur has to live on savings while building their business. These savings’ monetary value could have been invested in other things during that startup phase.
2. Staying at home to work late, or going out with friends?
Staying at home means that you produce valuable work, but you miss out on enjoyable activities and social interactions with friends that would refocus and motivate you. However, staying at home means that you won't spend money on food, drink, and any other activities, but you'll lose focus and motivation.
3. Maintaining a well-paying job you hate, or doing something you enjoy that pays less?
Maintaining a job you hate gives you financial value, but it drains your focus, motivation, and general happiness more quickly. You might need to look for additional sources of income because switching to a job you enjoy will likely result in less money. Additionally, it requires you to stop buying a particular item that you would have been able to buy using the money from your hated job.
4. Money or time?
An interesting concept is that having extra cash "buys" time if you are creative with outsourcing. Money buys technology and other people's time, so you can "save" time by spending certain amounts of money. Simple examples are outsourcing for tax preparations or doing laundry, signing up for a service to automate bill payments, or paying a travel agent to plan your vacation.
Because each person has different amounts of the basic resources, like time, money, health, focus, and motivation, the opportunity cost varies from one person to another. For this reason, we did not provide solid answers for "which is better" for each of these examples.
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